With a price-to-earnings (or "P/E") ratio of 26.2x NetApp, Inc. (NASDAQ:NTAP) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
NetApp has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
View our latest analysis for NetApp
What Are Growth Metrics Telling Us About The High P/E?
NetApp's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 51%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 8.8% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.
Looking ahead now, EPS is anticipated to climb by 18% per year during the coming three years according to the analysts following the company. With the market only predicted to deliver 13% each year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that NetApp's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From NetApp's P/E?
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of NetApp's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for NetApp that you should be aware of.
If these risks are making you reconsider your opinion on NetApp, explore our interactive list of high quality stocks to get an idea of what else is out there.
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